Vanguard has 3 S&P 500 Index Funds. How do you Choose?

I’m a big fan of passive index investing, where you basically pile all of your investments in to index funds and don’t try to time the market. For the amateur investor, it is hard to beat the performance of this strategy – heck, even the pros rarely consistently beat the indexes over time.

Performance aside, it is the simplest, least stressful way to actually invest your money (and no, digging a hole in your back yard and dumping in stacks of cash or letting it sit in a savings account earning negligible interest are not forms of “investing”).

If you invest in index funds, it is likely that you have an S&P 500 investment in your portfolio (the S&P 500 tracks 500 of the largest companies in the U.S.). And Vanguard’s are the cheapest, making them a preferred option.

Even Warren Buffett, quite possibly the best investor of all time, is a fan of index investing. In his most recent shareholder letter, he had this to say about where he would suggest the trustee of his estate put his money when he died,

“10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund (I suggest Vanguard’s).”

But… wait a minute!

Vanguard (the low cost leader in index funds) actually has three index funds that all invest in the same 500 companies. What is the difference between them? A friend just happened to ask me that question recently,

“Vanguard has three S&P 500 index fund investments: VOO, VFIAX, and VFINX. What is the difference, and which should I buy?”

I don’t give advice on what individual investments to pick, for a number of reasons. However, education is fair game.

The first difference you will notice is that VOO is an ETF, while VFIAX and VFINX are both index mutual funds. ETF’s (short for exchange traded funds) and mutual funds differ in how they are traded and evaluated. ETF shares are traded (and evaluated) on the stock market throughout the trading day, while mutual fund share purchases/sales are executed after trading has closed for the day. Mutual fund share prices are determined by the net asset value (NAV) of all of the holdings. ETF market prices may be influenced by the NAV of the holdings, but are based on the actual buy/sell trading volume and not the value of the holdings.

This has a real-world impact on your cost. Investment brokers will charge you on the initial purchase or sale of a mutual fund (but not adding additional shares). With ETF’s, you are charged each time you buy or sell shares. This is a key distinction if your investment broker is anyone other than Vanguard (where you can buy/sell ETF’s and mutual funds at no charge).

The next big difference is in the expense ratio – what you actually pay for the management of the funds. You’ll notice VFINX has an expense ratio of 0.17% (very low by most standards), while VFIAX is less than a third of the expense ratio at 0.05%. The reason is that VFIAX shares are considered “Admiral” (a fancy name for preferred) shares. Vanguard has Admiral shares for many of its index funds. They are significantly lower than their otherwise identical counterparts, but they have the stricter requirement of maintaining a minimum total balance in that fund of at least $10,000 for most funds. That’s really the only difference.

VOO, on the other hand, also has the lower 0.05% expense ratio. And there is no minimum investment.

Finally, how about performance? You’ll notice that there is virtually zero difference in performance between the three investments, over time. Below is a chart of the three over the past year. You can see tiny variations between VOO versus VFIAX and VFINX (which are identical). This is due to the difference in evaluation and how they trade. However, VOO trends to the same performance as the other two over time.

Performance differences between the three should not impact which you purchase.

If you have enough to qualify for the Admiral shares (VFIAX), they are cheaper than the regular shares (VFINX), making them the clear choice between the two.

If you invest outside of Vanguard at a brokerage that doesn’t have free ETF trading for VOO, then the mutual funds are probably the cheaper route. If you invest with Vanguard’s brokerage, VOO and VFIAX are nearly identical in appeal, if you can meet VFIAX’s minimum.

Great post. I do have a question… I have access to 30 free equity/ETF trades at my brokerage. MerrillEdge.

Would the VOO etc option be any different than VFIAX?

Other than VFIAX’s requirement to have a minimum balance of $10,000. I would think VOO with free trades at any broker would provide a means for folks to buy into this fund with smaller increments and be able to do dollar cost averaging over time.

Equal weight index funds generally outperform market cap weighted index funds. RSP has a fairly low expense ratio of 0.4%, which it easily makes up in return. For any duration over a year RSP has outperformed VOO after expenses. This outperformance is logical because with an equal weight fund you are buying the same amount of each company, whereas in a ‘normal’ S&P 500 index fund you are buying more of the faster *grown* companies. This results in 18.1% of your investment being concentrated into the top 10 companies in the portfolio vs 2% for top 10 in an equal weight fund. Put another way: equal weight funds are a better diversification of your resources, and diversification is the point of index investing.

Can anyone explain whats the difference between an ETF and lifecycle fund? I’m currently investing in Vanguard’s lifecycle 2050 fund. It has a .18% fee rate. This came highly recommend to me as a very passive form of investing.

I’m curious to know what an ETF discussed in the article is different from a lifecycle.

Unless you’re referring to something I’ve never heard of, lifecycle funds are target retirement funds made up of other Vanguard funds (international and domestic stocks and bonds, and eventually cash as retirement approaches) that automatically grow more conservative as you near retirement. Most regular Vanguard ETFs aren’t as diverse, just trying to mirror the S&P 500, the international bondmarket, etc. and never rebalance themselves.

FWIW, having read Bogle’s “Clash of Cultures: Investment vs. Speculation”, the Vanguard founder does not think highly of ETFs. Not that they can’t be used the same as an mutual fund for long term investment, but they are designed around the mindset of speculation / day trading / market timing, and have the incredibly high churn to indicate they are being used this way.

And, while this doesn’t reflect the Index ETF per se, ETFs in general have sliced up the market into so many commodities that they are clearly meant for people who think they can time the market and choose winners and losers. This is the exact kind of thing Bogle has argued against his whole career and why he “invented” low cost index mutual funds.

He thinks this even of Vanguard index ETF’s?
Sure, they can be used that way – just as credit cards can be used to dig yourself in debt. But if you are a responsible investor (or pay your balance in full each month), they can be incredibly advantageous.

For me the convenience of being able to see up automatic investing in my Roth is worth payijg the extra 0.12%. After all, if I had to do this manually each month I may be less likely to make the contribution at al. I love Vanguard.

According to national averages, I expect to live another 11 years. At 70, females are likely to live to 81. So, should I put some of my social security aside in an EFT or mutual fund to help with living
expenses that will no doubt increase. Note, I have no other income
except social security.

I’ve chosen to invest in VTSAX (Vanguard Total Stock Market Index Fund, admiral share class) rather than VFIAX (Vanguard 500 Index Fund, admiral share class) with the goal of increasing diversification. Do you have any thoughts to throw either way at that? Great blog!

Came across your article there and found it very helpful. Clarified a few doubts for me. I’m 24 and reading a lot about investing at the moment, with the view to beginning quite soon. Problem is my situation is a bit different. I’m Irish and currently live and work in Malaysia. I’m sold on the idea of tracker or index funds. Especially one following the S&P500.

Anyway I need a legitimate offshore account as I want to start investing properly. Would you recommend anyone in particular? As all the offshore brokerages seem to only offer the ETF version of Vanguard. I wanted the VFIAX admiral which is an index/mutual fund. The ETF seems like I would incur more costs? Would there be any real difference in buying the ETF? Any help/info would be greatly appreciated!

I wonder how many of the readers here have been able to restrain themselves from becoming “traders” with their ETFs. Working thru Vanguard may avoid broker fees, but those who don’t go that route are opening themselves to becoming players with fees every time they make a change with very costly reults!

At Merrill Lynch, I get 30 free trades per month. After that, trades are $5. Its not that expensive at all. However the only trades I have done on any Vanguard ETFs are for their ETFs: VTI, VEU, BND, VNQ, and VNQI and only for buys. Not sold a thing as of yet.

If you are focused on building for longterm with index ETFs you shouldn’t be “trading” anyway. Just strategic buys when you have the money available and the price is right, and strategic rebalancing when necessary. So far, I’ve only added shares to my portfolio not sold any. Rebalancing for me meant to lessen my cash allocation and increase equities on certain positions to get to the allocation I desired.

Eye-opening article but people should remember that moving money from one “taxable” account to another will result in capital gains/dividend taxes. I have $100K in a taxable VFINX fund and moving the money to a cheaper option would NOT be cheaper at all.